Financial crisis management and the use of government guarantees

The OECD hosted a Symposium in October 2011 that focused on bank failure resolution and crisis management, in particular, the use of guarantees and the spill-overs between the credit qualities of sovereigns and banking systems. Policymakers and academics engaged in open dialogue on these issues and discussed policy solutions. The discussion was timely, as we once again contemplate using guarantees to achieve financial stability.

The papers below were prepared for and presented at the Symposium and have since been published in a special issue of Financial Market Trends.

This article discusses policy responses to financial crises, with a particular focus on the US experience with government intervention during the 2008-09 financial crisis. It also reflects on the possibilities for conducting crisis management without financial guarantees.

The government guarantees on bank bonds adopted in 2008 in many advanced economies to support the banking systems were broadly effective in resuming bank funding and preventing a credit crunch. The guarantees, however, also caused distortions in the cost of bank borrowing. Their reintroduction might help alleviate the current pressures on banks caused by the sovereign debt crisis, but the pricing mechanism should ensure a level playing field.

This article focuses on the interconnections between the value of sovereign and banking debt that are created through sovereign guarantees for the banking sector. It explores the interrelationships between sovereign and banking sector debt and the value of insurance of risky bank debt when the sovereign providing a guarantee can itself be risky.

The report assess the potential impact of a crisis in the banking sector on public finances in four selected EU Member States and finds that in two of them governments are likely to have to cover losses generated in the banking system.

The financial crisis exposed serious flaws in the European framework for cross-border banking, including deposit insurance. Iceland’s experience shows that sizeable cross-border banking operations in small countries with their own currency come with very significant risks.

The macro-prudential authority is being adopted by monetary policy authorities as a means to limit systemic financial risks in the light of weaknesses revealed by the crisis. This article outlines the powers, scope and accountability that should characterise the macro-prudential authority.

Dalvinder Singh (University of Warwick) and John Raymond LaBrosse (University of Warwick)

The article sets out a framework for the decision-making process of financial safety net participants in managing financial crises. It discusses issues of micro- and macro-prudential oversight and argues that more needs to be done to ensure accountability, independence, transparency and integrity of the various actors of the financial system safety net.

While neither the legal nor institutional framework in Germany were adequate for dealing with stressed banks in the recent financial crisis, the newly established Federal Agency for Financial Market Stabilisation fills that gap. Initially focusing on rescuing banks, that agency now focuses on restructuring them.